Economic Update: August 23, 2021

Growth

2Q21 real GDP grew at a 6.5% q/q seasonally adjusted annual rate. Increases were broad based and were partly offset by decreases in inventories, residential fixed investment and government spending. While growth fell short of the consensus 8.5% estimate, real output has now surpassed its previous peak in 4Q19. Weaker inventories weighed heavily on growth, and as businesses restock in upcoming quarters, inventories could be a significant contributor to GDP growth. Manufacturing PMIs continue to show robust growth albeit at a softer pace than June, with the ISM Manufacturing PMI declining to 59.5 from 60.6. The ISM services PMI set a new record of 64.1 in July, showing service sector activity remains strong despite supply issues.

Jobs

The July jobs report showed strong improvement in the labor market as the economy barrels toward full employment. Total nonfarm payrolls increased by 943,000 in July, beating consensus expectations, with the leisure and hospitality industry continuing to drive hiring momentum. The unemployment rate fell to 5.4% from 5.9%, while the labor force participation rate edged up to 61.7%. Notably, wages rose 0.4% m/m and 4.0% y/y as excess labor demand pressures wages higher. JOLTS job openings rose to a fresh record high of 10.1m, now eclipsing the total number of persons unemployed by 1.3m.

Profits

The 2Q21 earnings season has been spectacular, with 459 companies having reported (90.8% of market cap). Our current estimate for 2Q21 earnings is $52.23. Thus far, 85% of companies have beaten on EPS estimates, and 83% have beaten on revenue estimates. Following blowout 1Q21 earnings, many companies have now recovered to the revenue/EPS levels of 2019 and are setting fresh highs. Oil prices (+143.4%) and the U.S. dollar (-7.6%) have continued to be tailwinds to earnings.

Inflation

Inflation has now well surpassed the FOMC’s 2% target, as the headline PCE price index rose +0.5% m/m and +4.0% y/y in June. The core PCE deflator also accelerated to +0.5% m/m and +3.5% y/y, falling short of market expectations. The July CPI report showed consumer prices rising at their fastest 12-month rate in more than a decade, but the moderation in the month-over-month pace signals that some of the drivers of much higher inflation are beginning to subside. Headline CPI for July rose +0.5% m/m, from 0.9% in June, and +5.4% y/y, while consumer prices excluding food and energy rose +0.3% m/m and +4.3% y/y.

Rates

At its July meeting, the Fed voted to maintain the current federal funds target rate in a range of 0.00%–0.25% and maintain the pace of asset purchases. The statement language was largely balanced in reflecting the committee’s outlook, although signaled tapering could begin later this year. The Fed did note that the economy “has made progress” toward its goals, although it was not yet willing to call that progress “substantial.” Nevertheless, it’s clear the committee recognizes the need to reduce accommodation in the quarters ahead. In line with this, we believe the Fed will announce a timetable for tapering at its September meeting, and begin to taper the pace of its purchases in December.

Risks

• The delta variant and global vaccine delays could slow the economic reopening.
• Inflation could spike in the medium term.
• Extremely accommodative monetary and fiscal policies could lead to a boom-bust recession.

Investment Themes

• U.S. equity investors may use earnings as a guide in a rising rate environment.
• Fixed income investors may underweight bonds and maintain short duration in a rising rate environment.
• Long-term growth prospects, a falling dollar and cyclicality support international equities.

This weekly update provides a snapshot of changes in the economy and markets and their implications for investors.

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